Deflation Deepens as Japan Contraction Risk Intensifies: Economy

Nissan Motor Co., Japan’s second-largest automaker, has repeatedly called on the government to extend subsidies and is introducing the new Note compact and the Serena S-hybrid minivan to spur demand. Photographer: Kiyoshi Ota/Bloomberg

Aug. 31 (Bloomberg) -- Japan’s consumer prices slid at a
faster pace in July and industrial production unexpectedly
slumped, raising the danger that the world’s third-largest
economy has slipped back into a contraction.

The benchmark price gauge, which excludes fresh food, fell
0.3 percent in July from a year before, putting the central
bank’s 1 percent inflation goal further from reach, a government
report showed in Tokyo. Industrial output fell 1.2 percent. A
private measure of manufacturing for August was the lowest since
the aftermath of the record March 2011 earthquake.

Today’s releases reflect diminishing demand overseas for
the nation’s exports amid the European crisis and exchange-rate
appreciation, and the end of incentives for vehicle purchases.
With Prime Minister Yoshihiko Noda’s government today predicting
it will miss a deficit-reduction target, pressure may rise on
the Bank of Japan to expand stimulus and sustain the recovery.

“The risk of a contraction in the second half of the year
is increasing,” said Junko Nishioka, chief economist at RBS
Securities Japan Ltd. in Tokyo, who previously worked at the
Bank of Japan. “The downside risks on the economy are
increasing, and could push the BOJ to further expand its asset-purchase program next month.”

The Nikkei 225 Stock Average headed for a second straight
week of declines, and closed down 1.6 percent in Tokyo. The yen
was at 78.54 per dollar, about 4 percent from its postwar high
reached in October 2011. The currency has soared 47 percent in
the past five years.

Phones, Games

The jobless rate was unchanged at 4.3 percent in July, a
government report showed today.

The slide in output was led by declines in the electronic
components sector, with production of integrated circuits for
mobile phones and video game consoles in Asia declining, the
government said. The trade ministry’s assessment that production
is “flat” remained unchanged from last month.

“The most shocking data was production,” said Norio
Miyagawa, a senior economist at Mizuho Securities Research and
Consulting Co. in Tokyo. The central bank may need to bolster
stimulus as the economy faces a deeper-than-expected slowdown,
Miyagawa said.

Japan’s weakening accompanies signs of slowing across Asia,
the region that’s led the global rebound from the 2007-2009
credit crunch. South Korea today reported a 1.6 percent drop in
industrial production in July from the previous month, after a
0.6 percent decline in June.

Rate Outlook

The decline in output makes a Bank of Korea interest-rate
cut likely in September, said Lee Sang Jae, a Seoul-based
economist at Hyundai Securities Co.

India, Asia’s third-largest economy, reported that its
gross domestic product increased 5.5 percent last quarter from a
year before. While the expansion beat economists’ estimates
after the central bank cut interest rates to support spending,
it may fail to ease pressure on Prime Minister Manmohan Singh to
revive a development agenda hampered by graft allegations and
political gridlock, as price pressures limit the central bank’s
room to cut rates further.

In Europe, German retail sales fell in July. House prices
in the U.K. rose this month from a month ago after declines in
June and July. The European Commission releases a report
projected to show unemployment in the region rose to a record
11.3 percent in July, according to a Bloomberg survey.

In the U.S., a Supply Management-Chicago Inc. index of
business activity probably showed a slower expansion in August
than a month earlier, while the Thomson Reuters/University of
Michigan’s final reading on consumer sentiment probably showed
no change from a preliminary reading of 73.6, according to
surveys of economists.

PMI Slides

In Japan, a manufacturing purchasing managers’ index
slipped to 47.7 in August, the lowest level since April 2011,
according to Markit Economics. A reading below 50 indicates a
contraction.

The economic deterioration adds to challenges facing Noda,
who is facing pressure from the largest opposition party to
follow through on a pledge to hold an early election, and whose
party holds a leadership contest next month. The government this
week downgraded its economic assessment for the first time in 10
months, citing weakness in global demand a week after a report
showed exports fell the most in six months in July.

Today, Noda’s administration reported that the primary
budget deficit -- which excludes payments on debt -- will be 2.8
percent of GDP in the 2020 fiscal year, short of the targeted
surplus, even if a sales-tax increase enacted this year is
phased in as planned.

Noda is also wrangling with lawmakers to get approval of a
deficit-financing bill that the government needs to cover its
shortfall. Finance Minister Jun Azumi told reporters in Tokyo
that spending cuts may come if passage is delayed.

Car Subsidies

Such a move would add to drags on the economy. About 88
percent of the 300 billion yen ($3.8 billion) budgeted for car-purchase subsidies has been consumed, damping the outlook for
the industry. After surging about 53 percent in the first seven
months of 2012, Japan’s vehicle sales may drop as much as 20
percent next quarter, according to analysts at BNP Paribas SA
and HIS Automotive.

Nissan Motor Co., Japan’s second-largest automaker, has
repeatedly called on the government to extend subsidies and is
introducing the new Note compact and the Serena S-hybrid minivan
to spur demand.

“This Japanese market needs stimulus to continue to grow
and compete on the world stage,” Andy Palmer, executive vice
president at Nissan, told reporters in Yokohama, Japan, at a
July 17 event to introduce the new Note. “We sincerely hope
those kind of incentives will be continuing.”

Revising Forecasts

The 1.2 percent decline in industrial output last month
compared with the median estimate for a 1.7 percent gain in a
Bloomberg survey of 27 economists.

“We will have to revise down our GDP forecast for the
third quarter” based on today’s data, said Nishioka at RBS, who
had previously seen a 2.1 percent annualized expansion. JPMorgan
Chase & Co. and BNP Paribas SA are among banks that had
predicted a drop in GDP even before today’s figures.

A decline in oil prices from a year earlier was the main
reason for the weaker consumer-price reading, Yoshiki Shinke,
chief economist at Dai-Ichi Life Research Institute in Tokyo,
wrote in a report before today’s release. Japan has increased
reliance on fossil-fuel imports after mothballing almost all its
nuclear power after the post-tsunami Fukushima reactor meltdown.

Yen’s Gains

Currency strength, spurred by Japan’s status as a haven
from global market turmoil because of its being the world’s
largest net creditor, also has toughened the BOJ’s job of
defeating the deflation that became entrenched in the economy in
the late 1990s. Exchange-rate gains cut the cost of imports.

The yen slid as much as 8.8 percent against the dollar in
the weeks after the BOJ shocked markets in February by
announcing a 1 percent inflation target and expanding its asset-buying fund. The relief for exporters was fleeting, as the
central bank refrained from expanding stimulus since April and
the currency resumed its climb toward a postwar record.

“Japan is still in a deflationary phase,” Masayuki
Kichikawa, Tokyo-based chief economist at Bank of America
Merrill Lynch, said before today’s release. “The bad news is
that the global slowdown has been prolonged so the BOJ will
probably have to delay its time line to achieve the inflation
goal.”

BOJ Governor Masaaki Shirakawa said as recently as a week
ago that the consumer price index will “gradually rise to a
range of above 0.5 percent” toward the end of the fiscal year
that starts April 1, 2013. “Thereafter, it will likely be not
too long” before it reaches the BOJ’s 1 percent goal, he said.

By then, Shirakawa’s term at the BOJ’s helm will have been
over by more than a year.